Reverse Gold Rush

California famously moved onto the national scene during the gold rush between 1848 and 1855. About 300,000 residents from the rest of the country flocked to the state. Though few made fortunes, the rush resulted in California's statehood in less than two years. More than 150 years later, California remains one of the fastest-growing states in the nation with projections that it (along with Texas and Florida) will add 11 million residents in the next 25 years, according to the U.S. Census Bureau.

But a funny thing is happening.

While Americans from other parts of the country — primarily the Northeast and Midwest — continue to flock to California and its immigrant population blooms, many native Californians are being priced out of the housing market and seeing their jobs moved to other states.

As a result, although people from the rest of the United States are flowing in, Californians are moving out. Indeed, near the equivalent of the entire 1850s population boom — 250,000 people — are fleeing from California each year, according to the University of Southern California Office of Demographic Research.

With cheaper housing and job growth to be found through the rest of the Southwest, Californians are conducting a reverse gold rush to Arizona, Nevada and Texas. And California-based retail developers and investors are following suit. That's part of what's behind projections that populations in Nevada and Arizona will double in the next 25 years, growing from 2.3 million and 5.7 million to 4.3 million and 10.7 million. In fact, three out of five new residents moving to Las Vegas and Phoenix each year come from California.

“The demographics really tell the story,” says Delores Conway, director of the Casden Forecast at the USC Lusk Real Estate Center, noting that the majority of California's population growth will result from in-migration of foreign immigrants and an increase in the birth rate.

Out-migration from California translates to a huge amount of retail growth throughout the Southwest, says Conway. This is evident in the amount of retail space being created in Southwest markets. CB Richard Ellis reported midyear that the Phoenix-metropolitan market delivered 2.2 million square feet of retail since last year, an additional 8.6 million square feet is under construction and 47.7 million square feet is planned. Las Vegas delivered 850,000 square feet of retail during the 2nd quarter alone, 6.4 million square feet is rising and more than 11 million square feet is planned. The Dallas/Ft. Worth area delivered 1.4 million square feet of retail during the second quarter and 7.9 million square feet is under construction.

In the meantime, with California real estate bringing record-high prices, local investors selling assets in-state and investing in other markets where prices are lower and they can get higher cash-on-cash returns. Los Angeles — based Paul Kenworthy, managing director for CCIM Investment Services Group at Charles Dunn Co., notes, for example, that some of his clients cashed out on apartment properties and acquired single-tenant retail properties in states with higher cap rates, doubling their cash flow.

Such arbitrages aren't limited to California-based investors. Susan Tupin, managing director and partner at New York — based Prescott Group LLC, a real estate investment and banking firm, notes deployment of capital from hot to less popular markets by “capital refugees” is a national trend. But with parts of California sporting some of the lowest cap rates in the country, a disproportionate number of investors are looking elsewhere for higher returns. In Orange County, for example, sales in the first half of the year were down 50 percent, according to Sperry Van Ness.

Kenworthy agrees, noting that with cap rates in the 4 percent to 6 percent range, people are putting down 50 percent equity to break even. “In the real world, an investor should be able to put down 25 percent to 30 percent and get a 3 percent to 5 percent return,” he says.

John McDermott, national director with the Sperry Van Ness, says that investors looking elsewhere are getting everything they had in California at a better price. One client sold a property in California for $200 per square foot and purchased a property in Tulsa, Okla., with similar national tenants for $38 per square foot. “It doesn't take a brain surgeon to figure out the fundamentals: same tenants, same credit, same demographics, and replacement cost is substantially higher than price paid,” he says.

Dan Malcomb, a broker at the San Diego office of Lee & Associates, says that real estate prices reflect a serious disconnect between seller expectations and what buyers are willing to pay with cap rates historically low and cost of debt rising. Consequently, the California market is cooling down, while Southwest markets are heating up.

He predicts that foreigners will increasingly invest in California real estate, because they are willing to pay exceptionally high prices for “trophy” properties. Rich Walter, of Irvine-based Faris Lee Investments, is already seeing an increase in foreign investors, particularly Australian and German real estate investment trusts and pension funds and individual investors from Asia.

“The market is still good,” he contends, admitting that a slowdown is anticipated based on where interest rates go. “In the institutional market, no slow down is expected, but it might not be the best bid on the table,” Walter adds, noting that's because institutions are unemotional buyers.

Noting concerns about how the market will look 12 months for now, he concludes, “Our clients are prepared. They are here for the long-term, and as long as tenants are doing OK and paying their rent, there's nothing to fear.”

Broader patterns

Development and investment in retail properties is following broader business patterns as California-based companies move operations out of state. Las Vegas and Phoenix are also popular with businesses expanding or relocating out-of-state because of their proximity to California, allowing these companies to move products quickly to California markets and executives to fly in and out in a day.

Larry Kosmont, of the Los Angeles-based Kosmont Companies, which publishes an annual Cost of Doing Business Survey for California, says, “We're seeing the start of a ‘showroom economy,’ with CEOs living here and moving the bulk of operations outside the state. Each year the list of negatives gets longer,” he adds, noting that top complaints include: loss of productivity due to traffic congestion, cost of housing for employees, high cost of employee benefits and the state's permissive litigation environment.

Following announcements last fall about Nissan moving its U.S. headquarters to Tennessee and Countrywide Financial taking 1,000 jobs to Phoenix, the Los Angeles County Economic Development Corp. compiled a list of 70 companies, with 13,000 jobs, that had recently left the state. The agency's Chief Economist Jack Kyser noted that the list did not reflect businesses headquartered in California that had quietly decided to expand in other states, like Countrywide creating 7,500 new jobs in Texas.

Texas, in fact, has profited the most from companies leaving the Golden State, according to a report from Boston-based consulting firm of Bain & Company, which found that 60 percent of jobs leaving California went to other U.S. states, but 40 percent of them went to Texas.

“Over the next 10 years, there will be incredible growth in the Southwest,” he predicts, noting that about one-third of his clients are now looking for opportunities outside the state. “The region could go through ups and downs, but long term, it's poised to grow.”

“Boomers are at an age when they are deciding where they personally want to live in the next three to five years and are buying in those markets,” says McDermott. “High net worth individuals can live wherever they want to — Jackson Hole, Salt Lake.”

Developer prospects

Prospects for developers in California are drying up as well, causing some to consider Arizona and Nevada a good alternative. High land and entitlement costs combined with the rising cost of construction have made it increasingly difficult to find profitable building opportunites in the Golden State. And with the residential market beginning to turn, prospects are not going to get any better for developers.

Graham Downes, a San Diego architect and developer who is designing projects in Las Vegas and San Diego, agrees, noting that small but growing Southwest markets are now attracting specialty retailers, whereas previously Wal-Mart was the only game in town.

When specialty retailers, like Banana Republic, come into these communities, people have a legitimate reason to shop, he says, suggesting this is good for the community because it stimulates the economy and supplies the creditworthy tenants attractive to retail investors.

As a result, project's like DMB Associates Inc.'s DC Ranch master-planned community are coming online to meet the demand from former Californians. The community includes Market Street Town Center in Scottsdale, Ariz., which includes 300,000 square feet of retail, dining and entertainment place.

On a more massive scale is Turnberry Associates' and Centra Properties' Town Square, a $750 million, 1.5-million-square-foot open-air center rising just south of Las Vegas. The project is scheduled to open this fall and will include more than 150 shops and 12 restaurants.

One of Malcomb's developer clients is also building a mixed-use project in Surprise, Ariz., at Stadium Village, which hosts spring training for Major League Baseball's Texas Rangers. “He got the land at $10 per square foot, which is unheard of here,” he says.

There's other benefits to building outside California as well, such as escaping all the red tape. “He doesn't have to go through the layers of bureaucracy we have in California,” Macomb says.